Working Paper

A puzzle of card payment pricing : why are merchants still accepting card payments?

Abstract: This paper presents models that explain why merchants accept payment cards even when the fees they face exceed the transactional benefits they receive from a card transaction. Such merchant behaviors can be explained by competition among merchants and/or the effectiveness of the merchant?s card acceptance in shifting cardholders? demand for goods upward. The prevalent assumption used in payment card literature?merchants accept cards only when their transactional benefits are higher than the fees they pay?holds only for a monopoly merchant who faces an inelastic consumer demand. A card network that wants all merchants in a given industry to accept cards sets a lower merchant fee initially and then gradually increases it to the highest possible level, which may be higher than the sum of the merchant?s transactional benefit and the merchant?s initial margin without cards. Such merchant fees potentially create inequality between cardholders and non-cardholders.

Keywords: Credit cards;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Payments System Research Working Paper

Publication Date: 2004

Number: PSR WP 04-02